Value the first commitment, then the re-ups. More than half of what an LP is worth comes from funds it has not yet agreed to.
Value the first commitment's fee profit and carry in today's money, then add each successor fund weighted by the odds the LP re-ups. On illustrative terms, a $25m commitment is worth $2.86m to the firm on its own, 11.44 per cent of the ticket. With a 70 per cent re-up rate and tickets growing 20 per cent a fund, the relationship is worth $5.98m, 23.93 per cent of the first ticket, and more than half of it arrives after the first fund.
Worked in full in Private Equity Investor Relations by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
An investor relations team is asked to justify travel, a placement agent, a first-close discount, a co-investment allocation or an extra hire, and each of those is spent to win or keep an LP. Without a value for the LP, the spending is argued by instinct. The calculation below is the one a head of IR can put in front of a management committee: what a new relationship is worth, and how much of that depends on the re-up rather than the first commitment. Every figure is illustrative.
| Input | Value |
|---|---|
| First commitment, $m | 25 |
| Management fee, years 1 to 5, on commitments | 2.0% |
| Management fee, years 6 to 10, effective on commitments | 1.0% |
| Share of fee revenue left after the firm's costs | 40% |
| Fund profit before carry, per $ committed | 0.8x |
| Carried interest, received in year 8 | 20% |
| Re-up probability for each successor fund | 70% |
| Ticket growth per fund; years between funds | 20%; 4 |
| Discount rate | 10% |
Fund III and three successors are counted. Fees are valued as profit, not revenue, because the firm spends most of its fee income running itself; the 40 per cent margin is an assumption to replace with your own. Carry is counted in full as the firm's, though in practice much of it belongs to the investment team.
Value of one fund = ticket × (PV of fees per $ × fee margin + PV of carry per $)
Lifetime value = Σ over funds k of value of fund k × re-up probabilityk ÷ (1 + r)4k
Excel, PV of fees per $: =NPV(10%,B2:B11) with the ten annual fee rates in B2:B11; PV of carry per $: =20%*0.8/(1+10%)^8
Step 1, fees on the first commitment. Five years at 2.0 per cent and five at 1.0 per cent is 0.15 per dollar, $3.75m nominal on $25m. Discounted at 10 per cent it is 0.0994 per dollar, $2.484m. At a 40 per cent margin the fee profit is worth $0.994m.
Step 2, carry. 20 per cent of 0.8 of profit is 0.16 per dollar, $4.00m nominal, received in year 8: 0.0746 per dollar today, $1.866m.
Step 3, the first fund. $0.994m + $1.866m = $2.860m, 11.44 per cent of the ticket. Carry is 65.3 per cent of it, which is why the value of an LP depends so heavily on the fund performing.
Step 4, the successors. Each later fund is larger, less certain and further away.
| Fund | Ticket, $m | Probability | Discount factor | Value today, $m |
|---|---|---|---|---|
| Fund III | 25.00 | 100.0% | 1.0000 | 2.860 |
| Fund IV | 30.00 | 70.0% | 0.6830 | 1.641 |
| Fund V | 36.00 | 49.0% | 0.4665 | 0.941 |
| Fund VI | 43.20 | 34.3% | 0.3186 | 0.540 |
| Relationship | 78.46 expected | 5.982 |
The LP is expected to be in 2.533 funds and to commit $78.46m in all. The relationship is worth $5.982m, 2.09 times the first commitment's value, and $3.122m of it, 52.2 per cent, comes from funds the LP has not yet agreed to.
| Re-up probability | Lifetime value, $m | Share of first ticket |
|---|---|---|
| 0% | 2.860 | 11.44% |
| 50% | 4.708 | 18.83% |
| 60% | 5.297 | 21.19% |
| 70% | 5.982 | 23.93% |
| 80% | 6.770 | 27.08% |
| 90% | 7.673 | 30.69% |
Between 50 and 90 per cent, each ten points of re-up rate are worth between $0.59m and $0.90m on this one relationship. With no ticket growth the 70 per cent case falls to $5.193m; with 40 per cent growth it rises to $6.912m. This is the arithmetic case for investing in reporting and service to existing LPs rather than only in new names. The firm-level version of the same question is in what re-up rate a successor fund needs.
A 2 per cent placement fee on the $25m is $0.50m: 17.5 per cent of the first fund's value, but 8.4 per cent of the relationship's. On first-fund economics alone it looks expensive; on the relationship it is a modest acquisition cost, provided the LP is the kind that re-ups. The same test applies to a first-close fee discount or a co-investment allocation: compare its cost with the relationship value, at a realistic re-up rate for that type of LP.
Valuing the LP on fee revenue. Undiscounted fees on the first commitment are $3.75m and look like the prize; on revenue rather than profit the relationship would appear to be worth $9.099m. Most fee income pays for the firm, and the part that is profit is concentrated in carry, which only exists if the fund performs. A relationship value that ignores performance and costs will justify almost any spending to win an LP. One that counts them tells IR where the money is: in the re-up, and the re-up is earned in the years between fundraises.
The fund's measures, the pipeline and the re-up arithmetic are in the free workbook for this case.
The present value of everything the firm earns from the LP across all the funds it is expected to join: fee profit and carry on each commitment, weighted by the probability of each re-up and discounted. On illustrative terms a $25m first commitment with a 70 per cent re-up rate and 20 per cent ticket growth is worth $5.982m over four funds, 23.93 per cent of the first ticket.
Less than the relationship is worth, at a realistic re-up rate for that type of investor. A 2 per cent placement fee on a $25m commitment is $0.50m: 17.5 per cent of the first fund's value of $2.86m, but 8.4 per cent of a $5.98m relationship. For an LP unlikely to re-up, only the first figure counts.
Because successor funds are larger and arrive every few years. In an illustrative case, raising the re-up rate from 50 to 80 per cent lifts the value of one $25m relationship from $4.708m to $6.770m, and at 70 per cent more than half the value, $3.122m, comes from funds after the first.
This article is one calculation from Private Equity Investor Relations. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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